A beneficiary has just received a claim payment for a life insurance policy. Which statement is true regarding federal income tax liability owed?

• A. No federal income tax is owed on life insurance proceeds
• B. The proceeds are fully taxable as income
• C. Proceeds are taxed only if interest is added
• D. Proceeds are subject to estate tax but not income tax

Answer: (A)

Life insurance death benefits paid to a beneficiary are normally not taxed as federal income. The IRS excludes the death benefit from gross income, so the recipient typically owes no federal income tax on the payout.

The only taxable portion that can arise is interest that accrues if there’s a delay in payment—the interest is taxed as ordinary income to the recipient.

Estate tax, not income tax, can come into play if the proceeds are paid to the deceased’s estate rather than to a named beneficiary; that’s a separate tax issue from federal income tax on the proceeds themselves.

So, in the common situation where a named beneficiary receives the death benefit, no federal income tax is owed on the life insurance proceeds. The tax concern would be limited to any interest earned on delayed payment, and, in some cases, potential estate tax considerations if the estate is the beneficiary.